3.8% Tax: What’s True, What’s Not

Ever since health care reform was enacted into law more than two years ago, rumors have been circulating on the Internet and in e-mails that the law contains a 3.8 percent tax on real estate. NAR quickly released material to show that the tax doesn’t target real estate and will in fact affect very few home sales, because it’s a tax that will only affect high-income households that realize a substantial gain on an asset sale, including on a home sale, once other factors are taken into account. Maybe 2-3 percent of home sellers will be affected.

Nevertheless, the rumors persist and the latest version that’s circulating falsely say NAR is advocating for the tax’s repeal. But while NAR doesn’t support the tax (it was added into the health care law at the last minute and never considered in hearings), it’s not advocating for its repeal at this time.

The characterization of the 3.8 percent tax as a tax on real estate is an example of an Internet rumor, says Heather Elias, NAR’s director of social business media. Elias and Linda Goold, NAR’s director of tax policy, sat down for a discussion of how the tax works and how Internet rumors work and you can find their remarks in the 6-minute video above.

Goold says the tax will affect few home sellers because so many different pieces must fall into place a certain way for the tax to apply. First, any home sale gain (principal residence) must be more than the $250,000-$500,000 capital gains exclusion that’s in effect today. That’s gain, not sales amount, so you really have to reap a substantial amount for the tax to even come into play. Very few people are walking away with a gain of more than half a million dollars today, even in the high-end home market, so right off the bat only a few home sellers would be a candidate for the tax.

For the few households that do see a gain of more than the $250,000-$500,000 exclusion (that’s $250,000 for single filers and $500,000 for joint filers), only the amount above the exclusion would be factored into the tax calculation, and that would still only apply to high-income households, which the law defines as single people earning $200,000 a year and joint filers earning $250,000 a year.

So, if you are a households with annual income of $250,000 or more and you earn a gain of more than $500,000 on your house (again, that’s after the $500,000 exclusion), any amount of gain above the exclusion would be plugged into a formula to see if it’s taxable. If it turns out that it’s taxable, then the amount could be subject to the 3.8 percent tax. If the household had a gain of more than $500,000 but only earned $249,000 a year in income, the tax wouldn’t apply.

(Note that these are just hypothetical examples. To know if a case would really be subject to the tax, a professional tax preparer or tax attorney has to look at all the particulars of the tax filer’s case. Only a tax professional is in a position to say the tax is applicable, but the examples cited here could help you get a sense of how the tax works.)

The other thing about the tax worth noting is that, although it takes effect in 2013, any impact on taxes wouldn’t happen until 2014. That’s because the tax filer would do the calculation in 2014 for the 2013 tax year. Because it’s not a tax on a real estate sale but rather on a capital gain, it’s not calculated at the time of an asset sale, whether that asset is a house or something else. It’s calculated at the time the filer figures his or her tax.

This is all explained clearly in the video, so if you have questions about how the tax works, or if you’re still hearing rumors about the tax and you’re not certain of the accuracy of what you’re hearing, the video should prove helpful.

“First, any home sale gain must be more than the $250,000-$500,000 capital gains exclusion that’s in effect today.”

That’s a misleading statement to make. Should say, “any PRIMARY home sale…..”

This law will effect a lot of the second and/or investment homes/ The 250/500k rule does not apply to non-primary homes, correct?

Robert Freedman

That’s a good point. The video makes clear that the $250,000-$500,000 capital gains exclusion applies to primary residences, so I’ll make sure that’s clear in the blog post. Thank you. Any gain on the sale of a second home would be added into the tax filer’s adjusted gross income, because the capital gains exclusion doesn’t apply. But, again, the tax wouldn’t kick in if the tax filer’s income remains under the threshold, which is $200,000 for individual filers and $250,000 for joint filers. And other considerations come into play before you can determine whether the tax will apply in the end, which is why consulting a tax professional is important. Let me direct you to a pamphlet that walks you through various scenarios, including one that’s based on the sale of a second home.

Robert Freedman

Thanks for your note. The tax is a tax on “unearned income,” so anything that is defined as unearned income is subject to the tax (after various calculations are made to determine how much, if any, is actually subject to it). Unearned income is basically capital gains, rents, dividends, and interest income. So, the sale of an investment property, to the extent it results in a capital gain, could potentially be subject to the tax. But many other factors come into play, including the amount of depreciation that’s taken, how much income the person has, and so on. Let me direct you to a pamphlet that walks through this and other scenarios on how the tax might apply. You would want to verify any scenario with a tax professional at the appropriate time.

Doug

Great forum and thank you all for your comments. Great points and great clarification of the information

Guess we get stuck in any case with just another item to increase the accountant’s and attorney’s fees or hours of our time to try to comply when the IRS employees probably don’t understand it themselves.

Commercial Real Estate is impacted significantly by this Tax. Upon the sale of investment property, Capital Gains will be taxed at 3.8% on the Total Gain, after adding back depreciation. For a $1,000,000 gain, that is $38,000. This is subject to the Capital Gains being less than the AGI of the owner.
See Example 7 in NAR’s publication: http://www.ksefocus.com/billdatabase/clientfiles/172/8/1437.pdf
(This is the same one referenced above as “pamphlet” from Robert Feldman’s blog post)

Scott Lamb

It’s not a tax on real estate except that it is but it only affects a small number of people. Let’s quit speaking with forked tounges. If we don’t defend the small number of people eventually it will be all of us.

gilda mcgonagle

just because it only affects 2-3 % doesn’t make it right mr. freedman. i would think that you, of all people, would be sensitive to that fact. today it’s 2-3%, tomorrow, it’s 10%, the next day, it’s 25%… well, you get the idea, right?

Liz Alanis

You forgot to include investment property because it is not given the same capital gains exclusion. So it will be taxed! This effects us and our investors; anyone who uses RE to build wealth will be penalized.

I’m in a vacation market where 70% of the transactions are for condos & homes that most owners classify as 2nd homes or investment property. 70% of my market is not a “small number of people”! The most reprehensible aspect of this TAX is the way it was passed. This is not the manner to responsibly produce a solution to the long term Medicare and Social Security problem.

Ginny Kelly

I watched the video and was stunned.. It’s almost as if the NAR organization is in support of this tax and mocking those concerned.

Lou Preli

This is another example of sneaky tax policies of the current administration. It has no place in a law for medical care,medicare,etc. If they insist on a tax on gain, there should be on deduction for losses also.

Ernest Siracusa

NAR has always fought aggressively against any attempts by government to reduce the mortgage deduction. NAR’s position on this obscene tax on “a few” wealthy individuals and households should be no different.

I am disguested by your wimpy obfuscation as you try to justify this tax which you admit was “inserted in the law at the last minute with no public hearing.” A taking is a taking no matter who is involved. So get some backbone NAR and EARN my respect. by denouncing this “redistribution” tax.

If this administration gets away with this tax….who is next on their attack list! It could be you,

Nevermind…I’m reading it wrong. $250-500k is the EXCLUSION amount. $200-250k is the AGI amount.
(This can be confusing!)

Diane

I think what this article helps to prove is another reason to end the current administration’s regime ASAP..hopefully in just a few weeks.
Unbelievable how all of these sneaky taxes were hidden into legislation, I believe illegally. God only knows how many others will be popping up on us over the next few years if he is re-elected.

Get the word out to all of your friends, family and acquaintances in how CRITICAL it is to get out and vote OUT our current Commander in Chief !!!!!

Clotilda Cassidy

I had calls on this from family and friends. Granted I do not make enough money for it to effect my life but the way it was done is upsetting. What has a tax on real estate got to do with health care?? Sneaky therefore scary I have to agree. But it seems the word got out to the people so we need to keep a close eye on things that effect our industry and let the voting public become aware now and in the future. I am having a hard time with this election.

Monika Harrison

Unfortunately, many attempts to clarify the actual provision and its effects on individual homeowners have been lost because the provision was tacked on to a health measure that is either loved or hated by almost everyone. During this political season, questions about the provision are almost always raised in a political context and satisfaction with the answer seems to depend not only on how one might actually be affected monetarily but on one’s personal political persuasion. I seem to get the question most often in an anonymously authored email forwarded by someone purportedly seeking the facts and yet providing of the facts doesn’t seem to do much to stop the same incorrect announcements from arriving in my inbox again.

Vincent

Actually, not true.
Any gain you make from any sale will be counted as unearned income AND will be added in to the rest of your unearned income. If, say, you make $50K from the sale of a home and have $200K in unearned income from other sources (not unreasonable for retirees who are liquidating hard-earned, long-term savings to pay for their bills, and who have required minimum distributions from your IRA), then guess what? You will be subject to the 3.8% tax (of course, you will also have paid taxes through the years on dividends and capital gains from your non-Roth savings, too, and not only when you cash them out).
Then, if you have to sit down with your accountant and she/he charges you $1000 to figure all of this out, then guess what also happens? Well, you can’t call this fee a tax, but it is an indirect tax paid to your accountant.
As always, this is not tax advice, and that’s another problem with the new taxes and with the self-proclaimed affordable health care act. It’s just plain hard to figure this out and to come up with any kind of accurate information, which you will need to have long before you figure out your taxes — by then it will be too late. Bottom Line: If you defer your gratification and try to save your money, you will soon become a rich predatory capitalist rather than a prudent investor.

Looks like the score on this one so far is Grasshoppers 1, Ants 0.

Brian Summerfield

Thanks for your note. The way the tax would apply is dependent on each individual’s tax situation, so you’re right, it’s advisable to work with a tax professional, and that does cost money. The $500,000 capital gains exclusion continues to apply, so there would be no tax if the home sale gains are under half a million dollars for a couple ($250,000 for an individual). Let me direct you to a booklet NAR put out last year that looks at different scenarios. Also, the IRS has yet to issue guidelines, so until that comes out, it’s unclear how the tax will actually apply in different situations. Thanks again for your comment.

Vincent

Addendum to my previous post: I should have started the second sentence with “As I understand it…” My apologies. This week, I attended an investment-related seminar discussing the new tax laws and one of the take-home messages was just how complicated and unpredictable the new tax changes will likely be, and how the complete picture has yet to be sorted out (and since the changes may be retroactive, you will need to know about them before they occur — anyone for time travel?)

Neal Messer

I too, am amazed how seemingly light this matter appears to NAR. First of all, they downplay the tax, then they say well the tax liability is only due when you file your 2013 tax way out there in 2014. This is an attack on real estate owership. Why was no call to action initated? We seem to do call to actions for a lot less demanding issues than this. Did NAR financially support any candidates in this election cycle that supported this tax?

Great information! I recently held an open house and a guest asked me that question for which I didn’t have a good answer. Thanks for clearing this up.

Buddy Hughes

For those of us who are involved in marketing vacation homes or investment property as well as those of us who own or frequently buy and sell investment property, we should be very concerned about our government as well as our professional organizations that try to brush by or smooth over bad legislation just because it affects a minority of real estate professionals. This is the way it starts and the way it ends is very easily predictable.

Jon Kilmer

My agency is listing a farm that has been in the same family for 150 years. The list price will be somewhere around one million. It is believed that a large amount of that will be capital gains. The five heirs placed the farm ownership in an LLC a few years ago, and rent out the land. A residence on the farm is being occupied by just one of the LLC owners. Will the 3.8% Obama Care tax apply to the capital gains income anticipated from the sale?
Thanks.
JK